Pyramid of assumptions
I find some of the recent analysis of US politics and its implications for financial and commodity markets, rather amusing. Most experts are presenting their prognosis of the future direction of asset prices (stocks, currencies, bonds, gold, oil, and other commodities) based on an upside down pyramid, with politicians and central banks as the primary basis of their assumptions.
The overly simplistic analysis indicates that the new US government will have to find a balance between the cost of servicing monstrous public debt (interest rates) and growth. The growth will look healthy in 2021 as the poor base effect kicks in; and so will the inflation. This shall prompt the Fed to normalize the policy rate to bring benchmark 10yr yields from present 0.95% to pre Covid level of 2.5%. This rise in yields will make the servicing of burgeoning debt extremely difficult, if not impossible. The Fed will therefore be forced to check the benchmark yields below the pre Covid levels, say at 2%. This will cause USD to tank another 10-20%, sending the prices of gold and other global commodities denominated in USD to stratosphere. Emerging markets, especially those exporting the commodities will gain significantly, at the expense of developed economies, particularly USA.
The analysis also assumes that a Democratic government in USA would work for normalizing trade relations with China, thus giving significant impetus to growth, leading to higher demand for industrial commodities.
From static empirical studies this analysis looks good. However, if we apply little accelerated rate of change to the historical economic trends, these assumptions may be lacking in many respects. For example, consider the following possibilities mostly ignored by these assumptions:
· US Government and Fed decide to correct the fiscal and monetary indulgences of past couple of decades, by devaluation of USD and letting USD retire as global reserve currency.
· Global commodities are no longer priced predominantly in USD. The share of neutral currencies (crypto etc.) and regional currencies (EUR, CNY, et al) increases substantially in global trade, making trade more bilateral than multilateral. (De-globalization)
· Digital transformation leads to material rise in productivity, further adding to deflationary pressures created by aging demography of the developed world.
· Consumption pattern change materially. The consumption of fossil fuels, steel, chemicals etc. declines structurally. (ESG)
· The logistic constraints ease substantially and supply of commodities is restored to the pre Covid level soon.
· Sino-US conflict is not about Trump or Republican standpoint. It is a conflict to retain (or gain) supremacy over global order. It continues to worsen with every new achievement of China. German Chancellor Merkel has led the European Union to conclude trade deal with China. This is despite Chinese aggression against neighboring countries; atrocities in Hong Kong; and suspicion over treatment of Alibaba promoter Jack Ma. Clearly, a strong anti US axis is emerging in the global order. The assumptions of high growth do not appear to be factoring the probability a sharply divided bi polar world, with few non-aligned countries.
· A global financial meltdown led by some financial institutions based in Europe or Britain.
Chart for the day